In “If You Plan to Succeed, You Need a Succession Plan” and “Succession Planning 101 – Steps 1 through 3 – Start with the Basics”, I discussed why business owners need to engage in succession planning (aka exit planning), listed ten steps as an overview of the planning process, and covered the first three steps in detail.
After completing steps one through three, you will have assembled your professional team, defined your personal financial objectives and timeline, and determined at least an approximate value for your business.
Now, it is time to turn your attention to developing and evaluating possible succession plan structures.
Step 4: Identify Your Desired Successor (Family, Key Employee, Third Party)
To have a succession plan, you need a successor. Typical potential successors would be one or more family members, one or more key employees, or an unrelated third party. Which of these is right for you depends on your circumstances. Do you have family members active in the business? Do you believe those family members have “what it takes” to run the business? Do you have key employees you believe have “what it takes” to run the business? Would your business be appealing to a third party purchaser? What priority do you place on the legacy of your business and whether it continues to be run after you are gone by people who you feel are of like mind to you? You should give these questions serious thought and determine who your desired successors would be in your perfect world.
Step 5: Assess Possible Succession Plan Structures Based on 2 through 4
With steps one through four completed, you should work with your team of advisors to develop and evaluate possible plan structures that might fit with the value of the business and your desired successors. These will include transaction type (transfer of business assets or business stock), purchase price (how determined and whether at a discount or a premium), payment terms (cash at closing or down payment with installment note – and if an installment note, over what term and at what interest rate), handling of management transition from you to successors, and handling of any business real estate (included in business succession transaction or excluded and retained by you).
Step 6: Evaluate the Financial Fit of the Possible Structures With Your Desired Personal Financial Objectives and Exit Timeline
Once you and your team have developed and evaluated possible structures that may work for the value of the business and for your desired successors, you need to evaluate the financial fit of those plan structures with your desired personal financial objectives and exit timeline. If your preference is to sell your business to your children, or perhaps key employee(s), will your children or key employee(s) be able or willing to pay you a sufficient amount at closing or within a sufficiently short period of time after closing to meet your financial objectives and exit timeline? If you would prefer to sell to a third party, will current market conditions support a third party valuation of your business that matches up with your financial objectives?
Step 7: Evaluate the Interpersonal and Psychological Fit of the Desired Successor With You and the Business
Finally, you need to evaluate the interpersonal and psychological fit of the desired successor with you and your business. This can be a difficult task and more art than science. While the financial fit relies heavily on mathematical calculations and forecasts, this fit is more subjective and difficult to assess. But, it is critically important to a successful plan and as the owner, you must be honest with yourself, perhaps even brutally so, in completing this step. If you don’t honestly believe that your son, or daughter, or key employee, or third-party purchaser is up to the task of owning and successfully running and growing your business, and if their failure to do so would undermine the financial viability of your succession plan, then that may not be the right plan for you. Or, if you believe the successor can succeed but is likely to turn the business into something you will not feel good about for your legacy, then that may not be the right plan for you.
Stay tuned for the follow-up post discussing the remaining succession planning steps eight through ten.
You can find previous installments of my series on Succession Planning 101 by clicking the links below.
Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation.